Gavin McCrone: Shetland shows the way to oil wealth

The islands' deft handling of North Sea resources highlights how the UK government squandered a golden opportunity

IT APPEARS only as a speck, if it appears at all, on most of the BBC weather maps. Many people in Scotland have only a hazy idea where it is, and in England they have even less idea. I was once asked by a senior official in the Treasury where it was and whether there was one island or two. It usually appears in a separate box on maps but shrunk to about half the scale of the rest of the country. Yet it has the lowest unemployment in Scotland, a GDP per head which is among the highest in Scotland and a very high standard of social services.

Shetland measures about 75 miles from Sumburgh Head to Muckle Flugga. Its total area is 567 square miles and it is 110 miles north of the Scottish mainland. The population of 22,000 live on 16 of its 100 or so islands. Compared with Orkney, there is relatively little fertile land, but the Shetlanders have always been a very self-reliant and enterprising community making the most of any opportunities available. In particular, the way in which North Sea oil has been handled by the council has given the community immense benefits, benefits which have not been evident in the rest of Scotland or the UK. Much of the credit for this must be given to the council's then chief executive, Ian Clark, a man of exceptional foresight and determination in some very difficult negotiations with the oil industry.

More than half of the United Kingdom's North Sea oil is in waters off Shetland, and when the oil was first discovered there were fears that the islands would be overwhelmed by a rash of uncoordinated developments, which would do major and lasting damage to the environment and give little lasting benefit to the local population. But the council took the unusual step of promoting private legislation through the UK parliament which gave them harbour authority powers for the whole of their coastline. This enabled them to require the oil companies to share a properly planned terminal in Sullom Voe, which became the largest oil port in Europe. As part of the deal, the companies paid a disturbance payment to the council, based on the throughput of oil. The largest part of this money has been paid into a charitable trust, legally separate from the council, which now has assets in excess of 210 million. The income is able to finance expenditure of approximately 11m a year.

This money has been used for a variety of charitable purposes benefiting the community. There are first-class leisure centres in all the main population settlements, there is exceptionally good care for the elderly, including specially built homes and visiting day carers, which reduces the burden that would otherwise fall on the NHS. There is investment in property to let and in a district heating scheme, both of which yield a return. The trust has also part-funded the excellent Shetland Museum in Lerwick. But perhaps most significant of all is a major investment along with Scottish and Southern Energy in Viking Energy, which has proposals for a large wind farm. Shetland, with its almost constant wind, is well suited to this, with turbines that give much higher availability than further south in Britain. The council, and now the Shetland Charitable Trust which owns the investment in Viking, believes that only by investing in renewable energy itself will the financial benefits accrue to the community.The Scottish islands deserve to benefit from such developments, and it is to be hoped that other island groups will benefit too. For too long in their past history they were exploited. To my mind, the most bizarre case was in Orkney. There, the pre-Reformation church, by fair means or foul, had acquired ownership of about half the land area. At the Reformation this transferred to the Scottish Exchequer, and after the Act of Union to the UK government. They then sold it and used the proceeds to plant trees in Hyde Park.

The Shetland story is not unique. Across the North Sea, Norway has invested much of its tax revenue from oil and gas in the Statens Pensjonsfond (state pension fund). Its assets now total approximately 350 billion, making it by far the largest sovereign wealth fund in Europe, and one of the largest in the world.

Britain's tax revenues have amounted to 158.9bn from the time the oil and gas were first produced until 2009-10. Had this sum, or anything like it, been invested, it would of course be worth substantially more by now and the income from it would have been a valuable source of revenue, just as it is in Shetland or in Norway. Why has the UK not done this? George Osborne, if he thinks about it, must wish that previous chancellors had invested at least part of Britain's tax revenue from North Sea oil instead of using it to finance current expenditure. Had this happened, Britain's finances would be much stronger now.

Tax revenues from North Sea oil are notoriously volatile, depending not only on the amount of oil produced but crucially on the international price. They reached a maximum of 12bn a year in 1984-85, but prices then fell sharply and revenues reached their lowest point of less than 1bn in 1991-92. In recent years they have risen again, returning to 12bn in 2008-09, but in real terms (after taking inflation into account) this was much less than at their peak in 1984-85. This means that the amount in any year is hard to predict, but the total remains very large indeed.

I was chief economic adviser at the Scottish Office in the 1970s and there were people, myself included, who argued then for at least some of the tax revenue from oil to be put into a special fund, and for part of this fund to be allocated to Scotland, as would have been likely to happen had the UK been a federal state like Canada. The Labour government considered this at some length, but the flow of tax revenue from oil was still small then and the country's finances were at that time in a very bad state. So no action was taken. So far as I know, the Conservative government after 1979 never considered the matter. Instead, the effect of oil combined with a tight monetary policy caused the exchange rate to rise dramatically so that much of manufacturing was forced out of business. In effect, the tax revenues from the North Sea ended up paying for unemployment. There is very little mention of North Sea oil in Mrs Thatcher's memoirs, though she could hardly have pursued the policies she did without it.

Today, with the country's finances again in a difficult state, putting the oil revenues in a special fund would mean that either other taxes would need to rise or public expenditure fall further to compensate. Even so, it should probably still be considered when circumstances get easier. But oil production is now past its peak, and even if production can be expected to continue for many years yet, the remaining reserves are either in smaller or more difficult fields where costs are higher. The revenues will therefore decline unless the price of oil rises dramatically, even from the present high level. The SNP government has argued for such a fund, but it also relies on oil revenues when arguing that Scotland's taxes would cover its public expenditure. It cannot do both.

North Sea oil and gas were developed as a UK resource and UK taxpayers, not just Scottish taxpayers, contributed to the cost of supporting infrastructure. So responsibility in the critical years lay firmly with the UK government. But what has happened is that a capital asset has been run down to finance current expenditure. Economic history must surely record it as a great opportunity missed.

• Gavin McCrone was formerly chief economist at the Scottish Office.